John Rogers' October Monthly Market Commentary
Before we reflect on the crash, we will provide a brief history of it as a refresher. The Dow Jones Industrial Average had risen from 776 in August 1982 to 2722 by August 1987 before correcting a bit through mid-October. Then on Monday, October 19th, the market plummeted throughout the day with the Dow sinking -22.6%. Most experts now agree “portfolio insurance” schemes caused a correction to morph into a crash. As you may recall, math whizzes were harnessing the power of computers to automatically reduce portfolios’ stock weightings when the market fell to insulate from further losses. When a bunch of big investors piled on, the market dropped, the computers sold, causing the markets to drop more, and so forth. In short, a classic snowball effect drove Black Monday. But most people simply saw a crash out of nowhere with little explanation and big losses—and found it very scary. It took just more than two years for the market to re-take its highs.
Ariel’s experience at the time contrasted sharply. Founder and CEO of Ariel John W. Rogers, Jr. was employing a toolkit that differed dramatically from those using snazzy new computers in New York City. Specifically, he was reading about Warren Buffett in John Train’s The Money Masters and watching Sir John Templeton on Louis Rukeyser’s “Wall Street Week.” John was not using highly technical calculations to react against the market’s movements but was instead thinking about time-tested truths in order to outperform long-term. When the market sank, he recalled the words of Buffett in his 1986 Berkshire Hathaway letter: “attempt to be fearful when others are greedy and to be greedy only when others are fearful.” Meanwhile, the words of Sir John Templeton rang very clearly: “buy when there’s blood in the streets.” Instead of taking for granted what the many falling prices implied, he pondered a simple question: had the value of the American economy really fallen by nearly a quarter in just one day? He thought it very unlikely, deployed capital into purchases as best he could, and even called clients in order to recommend new investments.
Today, we think the data supports two very significant truths that Black Monday illustrates dramatically. First, although the market is typically quite efficient, on rare, brief occasions, it becomes very inefficient. Buying at those times can prove very rewarding. Second, we think beating the market through the speed and raw processing power of computers is tempting but misguided. Ultimately it means attempting to beat the market at its own game: efficiency. Once again we turn to the wisdom of Sir John Templeton: "If you want to have a better performance than the crowd, you must do things differently from the crowd."
The world has gone the other way. The efficient market hypothesis has morphed from a supposition into something like a cult. Money continues to pour into index funds and ETFs, despite shocks to the system such as the tech bubble and wreck from the late 1990s to 2002 and the breathtaking lows of early 2009. Moreover, computers are more involved now than ever before, having created the massive waves of short-term trading generally referred to as “high-frequency” trading. They almost certainly played a huge role in the so-called “flash crash” of 2010, which was a jarring echo of Black Monday. And since the ‘80s, people think for themselves less and less when investing—especially professional investors. That is, managers who are paid to actively manage money have aped indexes more and more. According to Antti Petajisto of the NYU Stern School of Business, in 1980 about 60% of managers were “highly active” and now less than 20% are. Meanwhile, closet indexing was a single-digit percentage of managers in 1980—now nearly one-third of all managers run money that way.
In order to make our case for these lessons, we present returns from the day before the crash, the day of the crash, and the day after the crash through October 31, 2012. Represented are our flagship Ariel Fund (our only fund at the time) and the small-cap Russell 2000 Index.
We think Sir John Templeton’s advice to buy when there’s blood in the streets clearly applies to Black Monday. As you can see, those who bravely bought on that day or the day after performed considerably better than those who simply held onto their investments. In very round numbers, small-caps returned nearly +700% from the day before the crash, almost +800% from the day of the crash, and just less than +900% the day after the crash. In a two-day span, investors received an exceedingly rare opportunity to boost their returns by 200 percentage points. Just as importantly, all these returns are testimony to the long-term compounding effect of stocks—at just the time when stocks seem scary. If any investors swore off stocks completely due to Black Monday, they made a truly costly decision. Second, our own returns make a strong case for highly active management, especially in such an environment. Ariel Fund beat its benchmark by just less than +325% cumulatively starting the day before the crash. Investments in Ariel Fund outperformed the benchmark by more than +350% the day of the crash as well as the day after—even though the benchmark’s own returns became much harder to beat.
Even a quarter-century later, few see Black Monday as a happy day. Given the lessons it taught us, and the sound investments we have made with those lessons in mind, it has been one of the most beneficial days in our firm’s history.
The opinions expressed are current as of the date of this commentary but are subject to change. The information provided in this commentary does not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. Analyses and predictions are based on assumptions that may or may not occur, and different assumptions could result in materially different results.
The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 8% of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. Currently, the fund’s benchmarks are the Russell 2500TM Value Index and the Russell 2000® Value Index.
Investors should consider carefully the investment objectives, risks, and charges and expenses before investing. For a current prospectus or summary prospectus which contains this and other information about the funds offered by Ariel Investment Trust, call us at 800-292-7435 or visit our web site, arielinvestments.com. Please read the prospectus or summary prospectus carefully before investing. Distributed by Ariel Distributors, LLC, a wholly-owned subsidiary of Ariel Investments, LLC.
Some calendar year returns for Ariel Fund were negative. Click here for historical annual returns from 1987 to 2011.